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Article / 23 June 2015 at 23:19 GMT

Worst-case Greece scenario is tolerable, so be bullish

Blogger / MoreLiver's Daily
  • Despite optimism about a deal, the Greek crisis will eventually lead to losses
  • The losses will be manageable, but could increase political risks
  • European equity markets may be about to jump higher

By Juhani Huopainen

There is a whiff of optimism at the moment that the Greek crisis could be solved. Unfortunately looks can be deceiving. Solving the acute cash shortfall only amounts to kicking the can down the road rather than addressing and fixing the real problem.

Greece is not competitive, and this coupled with deep fiscal cuts and high output gap has guaranteed that the debt that was too high before the onset of the euro crisis, too high after both the first two bailouts, and too high after the sovereign debt restructuring of 2012 is still unsustainable.


While debt forgiveness would be a non-event in economic and budget terms for the Eurozone, the political fallout from default could force a Grexit. Photo: iStock

The Greek government’s debt is now almost completely held by the official creditors. So restructuring it would cause real losses not to investors, but European taxpayers.

Sending cheques to yourself

There has been a pause in the final payments of the second bailout. Everyone knows that Greece needs a third bailout in order to be able to pay back its earlier bailout loans. The funds have gone largely to creditor country banks, which were the original creditors.

In essence, the creditor countries are complaining that they have bailed out their own banks, and now complain that they will have to recycle money – send it to Greece so Greece can send it back.

Sure, there are reasons to be angry at Greece because the country falsified its national accounts and its pace of reforms has been slow. But even the International Monetary Fund already admitted in 2013 that the original programme was flawed and too optimistic. In short, Greece never had a chance, and no-one is innocent.

Despite a possible kicking of the can now, eventually there will be losses for European taxpayers. The losses will be just as real, whether they come from voluntary debt forgiveness or an outright default by the Greeks. Possibly the creditor countries would prefer to push Greece into a default, so that they could put the blame for the losses solely on Greece.

Worst-case – losing everything, but tolerable

Let’s assume that the worst happens and Greece defaults completely on every possible item: the bilateral loans, the loans from the European Financial Stability Fund, the bonds held by the European Central Bank, Greece’s TARGET2 liabilities, including the Emergency Liquidity Assistance, which is provided by the Greece’s national central bank, and should be repaid to the ECB in case of a Grexit – but not necessarily would be repaid.

According to data from Bloomberg and Barclays, the Eurozone’s official exposure to Greece is roughly €330 billion, which equals 3.3% of the single currency area’s GDP. That sounds like a big deal, but let’s look at Eurozone debt and deficit levels first.

Eurozone government budget deficit was at post-crisis low of 2.4% in 2014. As Germany had a small surplus, the median deficit is higher. On average, the exposure to Greece is equivalent to the annual budget deficit of  Eurozone member nations.

Greece exposure

Chart source: Saxo Bank

The European Central Bank’s sovereign bond purchase programme has managed to push bond yields to low levels, even given the recent spike higher. All of the countries have market access. I don’t think Spain’s debt sustainability would be significantly worse if its debt-to-GDP rose from 98% to 101.7%, or in case of Netherlands, from 69% to 71.9%.

There will be no meltdown, because there are no private creditors left holding Greek bonds who could cause a Lehman Brothers-type chain reaction in the financial system.

Debt forgiveness would be a non-event both fiscally and in economic terms for the Eurozone. The political risks within the crisis and creditor countries are a different matter, especially in case of a default, which would probably force Greece to exit the monetary union. I will discuss these risks in my next article.

DAX correction

For now, note that the Germany's DAX index has just seen a 13% correction, which is about as much as it normally corrects to the downside. The daily chart (see below) shows a flag pattern. Flag patterns are continuation patterns within a longer trend, and are thought to lead to a resumption of the trend once the price breaks outside the pattern.

The index sits very close to the upper end of the flag at the moment, and could see an impulsive breakout soon.

Flag pattern in the DAX
DAX daily

Chart source: Saxo Trader. Create your own charts with SaxoTrader; click here to learn more.

See also: April 28: It's decision time on Greece

– Edited by Robert Ryan

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.
thewickedwiz thewickedwiz
Good point, however one must see two aspects.
Europe has lost all credibility as a political unit and even the gullible public has been astonished by this farce.
Germany knows it must now weaken the Euro substantially and will welcome flooding the markets with money.
This is bullish for equities but should hit the currency
Juhani Huopainen Juhani Huopainen
I disagree. The public seems to see Greece as the source of all evil in the world. Media has helped. The EU/euro area's reputation has been tarnished, but only outside the euro area. Editorials, economists, bloggers etc outside the euro area overwhelmingly point the finger to the terrible crisis management and how the key institutions have put lipstick on the pig repeatedly.

But within the euro area's mainstream, the story of evil, lazy Greeks who do not even negotiate properly and are free-riding communists has been the norm.

But as I promised, more on the "political risks" in my next text - be patient!
thewickedwiz thewickedwiz
Well beg to respectfully disagree, I actually talked to "stalwart" Euro believers in the Eurozone and almost everyone thinks that the fact that the politicians keep coming back for more talks is ridiculous.
I admit that the Greeks get the most flak but Juncker and the others especially the eurocrats are no longer taken seriously. Small wonder in my mind.
Juhani Huopainen Juhani Huopainen
I do agree with your market view, and only wanted to point at that the general population thinks "It's Greece's fault". People in the markets and economics know differently (you and me included), but couple of FT columnists and economics PhD's can't change politics alone.
thewickedwiz thewickedwiz
Well on this I tend to agree they (the gift bearers ) are most at fault , but if Bloomberg is to be believed (an hour ago) and two "great" leaders just offered a 5 month standoff with money attached...(big money) then we really have to look at both sides and see how incompetently they have dealt with the problem.
Originally the Germans wanted the IMF in to somehow impose some discipline on the Greeks.
Now it seems they are all scared that the IMF will suddenly be left in the cold and they would like to plug that.
Soon it will be the European taxpayer alone paying for this giant bill.
One starts to have more sympathy for Cameron!


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